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Lemon Tree Hotels Limited: Rating Assigned for Enhanced Amount November 27, 2019 Lemon Tree Hotels Limited: Rating assigned for enhanced amount Summary of rating action Previous Current Rated Rated Instrument* Rating Action Amount Amount (Rs. crore) (Rs. crore) Long-term Fund-based – Term Loan 99.37 116.00 [ICRA]A- (stable); assigned/outstanding Long-term/ Short -term – Fund Based 30.00 30.00 [ICRA]A- (stable)/ [ICRA]A2+; outstanding Working Capital Short-term/ Short-term – Unallocated 4.11 0.00 - Total 133.48 146.00 *Instrument details are provided in Annexure-1 Rationale ICRA has taken a consolidated view of Lemon Tree Hotels Limited (LTHL), its subsidiaries, step-down subsidiaries and associate companies (the Lemon Tree Group) while assigning the credit rating, given the common management and significant operational and financial linkages between them. The rating assignment/reaffirmation factors in the consistent improvement in the financial and operating metrics of LTHL’s hotel portfolio in FY2019 owing to favourable demand environment across operative micro-markets. This enabled an improvement of 7% on a YoY basis in average room revenues (ARRs) coupled with steady occupancy of over 75%. On a consolidated level, the company reported a 13.5% and 24% YoY growth in operating income (OI) and OPBDIT, respectively, in FY2019. While there was delay in the launch of its Pune (city centre) and Mumbai (Andheri) properties, the ramp-up since their eventual launch (in December 2018 and June 2019, respectively) has been healthy and is expected to contribute meaningfully to profitability, going forward. In H1 FY2020, despite weak macroeconomic conditions and one-off events—such as the general elections and airline industry issues—the company reported steady occupancy levels and 3.8% average YoY growth in ARRs. Lemon Tree Premier Kolkata and ‘Aurika’ Udaipur (Rajasthan) were launched in Q3 FY2020, and given these high demand markets, they are expected to ramp-up swiftly. The rating continues to reflect ICRA’s expectation of continued improvement in the performance metrics of LTHL’s portfolio led by the improving maturity profile of its assets and ramp-up of new projects launched in demand-dense markets (Pune, Mumbai, Udaipur and Kolkata), even as overall demand growth prospects for the hospitality sector appear subdued in the near term. Furthermore, with only three projects under development, the project implementation risk stands substantially reduced. The rating continues to favourably factor in the diversified geographical presence of the Group hotels, the well- recognised, in-house brands such as Lemon Tree and Red Fox, its comfortable capital structure and extensive experience of the promoter in the hospitality industry. ICRA notes the favourable location of the properties (in prominent business districts with remunerative catchments) and portfolio expansion through an asset-light business models—viz. leasing of properties and management contracts. Although the properties at Delhi Aerocity, Hyderabad (Hitech City and 1 Gachibowli) and Bangalore (Ulsoor Lake and Electronic City) drive a significant proportion of the company’s revenues (~49% in FY2019), which exposes it to the risks of adverse region-specific development, the hotel portfolio is reasonably diversified across categories (upper mid-scale/midscale/economy) with presence in dispersed micro-markets. The same reduces the vulnerability of revenues to cyclical downturns or regional events to some extent. In July 2019, LTHL had announced the acquisition of Berggruen Hotels (BHPL), owner of the ‘Keys’ brand and a 1,911- room hotel portfolio in India. The acquisition carried out under FHPL (a 58% subsidiary of LTHL, with balance ownership by APG Asset Management Company or APG), was concluded on November 1, 2019 and BHPL became a 100% subsidiary of FHPL. Of the purchase consideration of Rs. 471 crore, APG infused fresh equity of Rs. 360 crore (76%) into FHPL in October 2019. The balance amount was funded by LTHL from internal accruals. This will limit any adverse impact on LTHL’s capital structure. On the operational front, the acquisition will provide LTHL ready access to new cities and potential to add hotels under new brands (Keys Prima, Select and Lite), without diluting its existing brand offering. This will augment LTHL's market share in the mid-scale hotel segment. Post-acquisition, hotels in Bangalore and Pune are expected to be rebranded as Lemon Tree hotels involving marginal capex (Rs. 10-15 crore), while others will continue under existing brands. BHPL’s performance, over the near to medium term, is expected to reflect synergistic benefits from LTHL’s established client base, marketing network, relationship with online travel agents (OTAs) and lenders. The company expects the Keys portfolio to generate gross operating profits of up to Rs. 50 crore in FY2020 (as against Rs. 32 crore in FY2019) with marginal impact on LTHL’s consolidated debt levels. The rating is, however, constrained by moderate return indicators (i.e., RoCE of 7.4% in FY2019) as investments in newly launched properties (Sector 60, Gurgaon, Banjara Hills, Hyderabad and City Centre, Pune) are yet to scale up adequately for meaningful contribution to profitability. Moreover, while the execution risk has reduced following planned launch of five (876 rooms) of the seven under construction properties over the last 15 months, the company has leveraged these new properties to fund the on-going capex in remaining projects. This debt-funded expansion over FY2020-FY2022, and incremental debt of Rs. 134 crore, related to the acquisition of BHPL, is expected to keep the financial leverage (TD/ OPBITDA) of LTHL elevated over the medium term, despite ramp-up of cash accruals from the operational portfolio. While project debt is yet to be tied up for the Mumbai Airport project, ICRA does not anticipate any delays in financing tie-up given the favourable location and almost entire project equity having been invested upfront. With ballooning debt repayments, the coverage indicators are also expected to remain muted. Nontheless, ICRA draws comfort from company’s financial flexibility emanating from its healthy asset base and management’s demonstarted track record of raising timely debt against projects, top up loans on operational properties and refinancing of high cost debt. Further, ICRA takes cognizance that the successful public listing of equity shares in FY2019 has improved LTHL’s financial flexibility, in terms of better access to capital markets and liquidity for shareholders. The rating also reflects the cyclical nature of the industry, with financial performance being prone to seasonality as well as economic growth. Compared to the 10% growth in FY2019, ICRA expects a muted industry revenue growth (~6%) in FY2020e due to weak demand. However, post FY2020, the demand is expected to pick up gradually with a compound annual revenue growth expectation of 8-9% during FY2020-FY2024. Further, the Indian budget hotel segment is characterised by relatively low entry barriers and numerous unorganised players. Thus, LTHL faces intense competition from standalone hotels in key micro-markets, organised players like Ginger, Ibis and Holiday Inn Express, and room aggregators like OYO, which may constrain its ability to scale-up revenue per available room (revPAR) and impact scale-up of profitability at anticiapated pace. 2 The Stable outlook on the rating reflects ICRA’s expectation that LTHL will continue to benefit from the geographically diversified and differentiated brand portfolio and a favourable medium-term demand outlook for the industry. Further, with the next phase of organic inventory expansion planned in FY2022–FY2023 (Mumbai Airport project), the current portfolio would get an ample time for stabilisation. Also, since all the recent launches have been in demand dense markets—Pune, Mumbai, Kolkata and Udaipur—these are expected to have comparatively shorter gestation period and thereby faster turnaround, supporting the overall portfolio metrices over the medium term. Key rating drivers and their description Credit strengths Healthy revenue growth; revenue visibility led by favourable demand-supply dynamics and BHPL portfolio integration – LTHL reported a 19% growth in revenues on a YoY basis in H1 FY2020, led by ramp-up of new inventory (Mumbai, Pune, Chandigarh and Dehradun) and steady performance across other mature properties. While the portfolio occupancy declined marginally to 76.1% in H1 FY2020 as against 77.5% in corresponding previous, portfolio revPAR improved by nearly 4% in the same period. The 12% increase in OPBITDA (pre Ind-AS 116 adjustment) was relatively lower, impacted by nearly 700 rooms in early stabilisation phase, minimum wage revisions across several states and increase in provident fund contributions. ICRA expects the FY2020 pan India revPAR growth to remain muted, impacted by the subdued demand environment. While the upcycle is likely to be impacted for a brief period, the strong demand expected over the medium term coupled with improving maturity profile of the LTHL portfolio and continued favourable guest mix, is likely to facilitate an improvement in ARR and occupancy, going forward. Further, with acquisition of the Key’s hotel portfolio, LTHL will be able to access a few currently unpenetrated markets, enhance presence in key markets like Bengaluru and Pune, and take up hotel enquires (for management contract) under new brands, which were earlier not tenable with the existing brands. ICRA expects the Key’s portfolio to benefit from LTHL’s
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